Capital market imperfections and the theory of optimum currency areas

Pierre Richard Agénor, Joshua Aizenman

Research output: Contribution to journalArticlepeer-review


This paper studies how within- and cross-country capital market imperfections affect the welfare effects of forming a currency union. The analysis considers a bank-only world where intermediaries compete in Cournot fashion and monitoring and state verification are costly. The first part determines the credit market equilibrium and the optimal number of banks, prior to joining the union. The second part discusses the benefits from joining a currency union. A competition effect is identified and related to the added monitoring costs that banks may incur when operating outside their home country, through an argument akin to the Brander-Krugman " reciprocal dumping" model of bilateral trade. However, in our framework, whether joining a union raises welfare of the home country is ambiguous; it depends on the relative strength of " investment creation" and " intermediation diversion" effects. © 2011 Elsevier Ltd.
Original languageEnglish
Pages (from-to)1659-1675
Number of pages16
JournalJournal of International Money and Finance
Issue number8
Publication statusPublished - Dec 2011


  • Capital market imperfections
  • Cournot competition
  • Currency unions
  • Intermediation diversion effect
  • Investment creation effect


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